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What do accruals tell us about future cash flows?

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Mary E. Barth
Mary E. Barth
Mary E. Barth
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Greg Clinch at Deakin University
Greg Clinch
Doron Israeli
Doron Israeli
Doron Israeli
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Our model, which is adapted from Feltham and Ohlson (Contemp Account Res 11:689–731, 1995) and Ohlson (Contemp Account Res 11:661–687, 1995) and extends Dechow and Dichev (Account Rev 77:35–59, 2002), characterizes the information about future cash flows reflected in accruals. It reveals investors can extract from accruals information about next period’s economic factor and the transitory part of one component of next period’s cash flow. The extent to which each accrual provides this information depends on whether the accrual aligns future or past cash flows and current period economics and whether it relates to the current or prior period. Thus each type of accrual has a different coefficient in valuation and forecasting cash flows or earnings. Each coefficient combines an information weight reflecting the information that accrual type provides and a multiple reflecting how that information is used in valuation and cash flow and earnings forecasting. The empirical evidence supports our main insight, namely that partitioning accruals based on their role in cash-flow alignment increases their ability to forecast future cash flows and earnings and explain firm value.
a The link between the components of cash flow from operations, CFOt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CFO_{t}$$\end{document}, and the economic factor, θt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t}$$\end{document}. CFOt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CFO_{t}$$\end{document} comprises three components: CFtA\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t}^{A}$$\end{document}, which is associated with the period t-1\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$t - 1$$\end{document} economic factor, θt-1\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t - 1}$$\end{document}; CFtC\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t}^{C}$$\end{document}, which is associated with the period t economic factor, θt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t}$$\end{document}; and CFtB\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t}^{B}$$\end{document}, which is associated with the period t+1\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$t + 1$$\end{document} economic factor, θt+1\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t + 1}$$\end{document}. b The link between the accrual-based performance measure, OPEARNt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$OPEARN_{t}$$\end{document}, and the economic factor, θt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t}$$\end{document}. OPEARNt=CFOt+ΔSFPtA+ΔSFPtB\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$OPEARN_{t} = CFO_{t} + \Delta SFP_{t}^{A} + \Delta SFP_{t}^{B}$$\end{document}, is an accrual-based performance measure that aligns cash flow components with the economic factor, θt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t}$$\end{document}, but with error. SFPtA\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$SFP_{t}^{A}$$\end{document} is statement of financial position accruals relating to next period’s cash flows driven by the current period’s economic factor, CFt+1A\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t + 1}^{A}$$\end{document}. SFPtB\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$SFP_{t}^{B}$$\end{document} is statement of financial position accruals relating to last period’s cash flows driven by the current period’s economic factor, CFt-1B\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t - 1}^{B}$$\end{document}
a The link between the components of cash flow from operations, CFOt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CFO_{t}$$\end{document}, and the economic factor, θt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t}$$\end{document}. CFOt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CFO_{t}$$\end{document} comprises three components: CFtA\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t}^{A}$$\end{document}, which is associated with the period t-1\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$t - 1$$\end{document} economic factor, θt-1\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t - 1}$$\end{document}; CFtC\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t}^{C}$$\end{document}, which is associated with the period t economic factor, θt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t}$$\end{document}; and CFtB\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t}^{B}$$\end{document}, which is associated with the period t+1\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$t + 1$$\end{document} economic factor, θt+1\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t + 1}$$\end{document}. b The link between the accrual-based performance measure, OPEARNt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$OPEARN_{t}$$\end{document}, and the economic factor, θt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t}$$\end{document}. OPEARNt=CFOt+ΔSFPtA+ΔSFPtB\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$OPEARN_{t} = CFO_{t} + \Delta SFP_{t}^{A} + \Delta SFP_{t}^{B}$$\end{document}, is an accrual-based performance measure that aligns cash flow components with the economic factor, θt\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\theta_{t}$$\end{document}, but with error. SFPtA\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$SFP_{t}^{A}$$\end{document} is statement of financial position accruals relating to next period’s cash flows driven by the current period’s economic factor, CFt+1A\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t + 1}^{A}$$\end{document}. SFPtB\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$SFP_{t}^{B}$$\end{document} is statement of financial position accruals relating to last period’s cash flows driven by the current period’s economic factor, CFt-1B\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$CF_{t - 1}^{B}$$\end{document}
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What do accruals tell us about future cash flows?
Mary E. Barth
1
•Greg Clinch
2
•Doron Israeli
3
Published online: 14 June 2016
ÓSpringer Science+Business Media New York 2016
Abstract Our model, which is adapted from Feltham and Ohlson (Contemp
Account Res 11:689–731, 1995) and Ohlson (Contemp Account Res 11:661–687,
1995) and extends Dechow and Dichev (Account Rev 77:35–59, 2002), charac-
terizes the information about future cash flows reflected in accruals. It reveals
investors can extract from accruals information about next period’s economic factor
and the transitory part of one component of next period’s cash flow. The extent to
which each accrual provides this information depends on whether the accrual aligns
future or past cash flows and current period economics and whether it relates to the
current or prior period. Thus each type of accrual has a different coefficient in
valuation and forecasting cash flows or earnings. Each coefficient combines an
information weight reflecting the information that accrual type provides and a
multiple reflecting how that information is used in valuation and cash flow and
earnings forecasting. The empirical evidence supports our main insight, namely that
partitioning accruals based on their role in cash-flow alignment increases their
ability to forecast future cash flows and earnings and explain firm value.
Keywords Accruals Cash flows Equity valuation Cash flow forecasting
Valuation model
JEL Classifications C13 C51 E37 G17 M41
&Mary E. Barth
mbarth@stanford.edu
1
Graduate School of Business, Stanford University, Stanford, CA, USA
2
University of Melbourne, Parkville, VIC, Australia
3
Arison School of Business, Interdisciplinary Center (IDC) Herzliya, Herzliya, Israel
123
Rev Account Stud (2016) 21:768–807
DOI 10.1007/s11142-016-9360-4
Content courtesy of Springer Nature, terms of use apply. Rights reserved.
... However, consistent with the FASB's explicit reference to earnings and its components (FASB 1978), Barth et al. (2001) find that earnings better predict future cash flows when disaggregated into components. More generally, prior evidence suggests that disaggregating earnings affects inferences about the statistical properties of earnings (e.g., Dechow et al. 2022Dechow et al. , 2008Casey et al. 2017;Barth et al. 2016;Dechow and Ge 2006;Richardson et al. 2020;Lipe 1986). Consequently, rather than draw conclusions about the relative predictive abilities of earnings and cash flows at the level of aggregate earnings, our study draws conclusions at the level of individual earnings components. ...
... See Dechow et al. (2022),Casey et al. (2017),Barth et al. (2016),Dechow et al. (2008),Dechow and Ge (2006),Richardson et al. (2020), andLipe (1986).Content courtesy of Springer Nature, terms of use apply. Rights reserved. ...
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... Finally, this study contributes to the literature on the predictive ability of accruals. Research generally finds that accruals and components of accruals contain useful information about future cash flows (Dechow et al. 1998;Barth et al. 2001Barth et al. , 2016Nam et al. 2012), though the predictive value of accruals is reduced when measurement difficulties induce errors into the accounting estimates (Lev et al. 2010;Glendening 2017). Our findings extend this line of research by showing that MCEs, that is, material changes in specific accrual estimates, also contain useful information about future cash flows. ...
... MCEs are a consequence of accrual accounting. Accruals enhance the predictability of earnings by altering the timing of cash flow recognition for earnings to better capture the firm's economic performance (Dechow 1994;FASB 2010;Barth et al. 2016). This process involves managerial discretion, whereby managers incorporate their private information about the current and future economics of the firm into earnings through discretionary accounting choices, such as MCEs. ...
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